Interest rates are on the rise. As the Federal Reserve raises its benchmark rate to combat inflation, consumers will feel the effects through higher borrowing costs. Both new and existing loans will be impacted, from mortgages and auto loans to credit cards and student debt. Understanding how increasing rates will affect your finances is key to managing higher payments.
How Interest Rates Affect New Loans
When the Federal Reserve raises rates, the cost of borrowing money goes up. Banks and lenders pass on increased interest rates to consumers taking out new loans in the form of higher annual percentage rates (APRs). This means you’ll pay more in interest charges over the lifetime of the loan.
Here’s how rising rates impact common new borrowing scenarios:
Mortgages
Mortgage rates tend to move in sync with the 10-year Treasury yield, which is influenced by Federal Reserve rate hikes. As rates rise, homebuyers will pay more in interest when taking out a new mortgage. On a $300,000 home loan, an increase from 3% to 4% would mean paying $91 more per month and $32,000 more in interest over 30 years.
Floating-rate mortgages directly adjust to rate hikes, so payments fluctuate up and down. Fixed-rate loans lock in an interest rate, but resets on refinancing will carry higher rates. ARMs also eventually adjust upward. Shopping for the best rate and locking early are key for homebuyers.
Auto Loans
Auto loan APRs are also headed upwards, meaning larger monthly payments on new vehicle purchases. For example, a $30,000 car loan at 4% over 60 months would cost $550 per month. At 5%, the monthly payment jumps to $570, or $30 more. That adds up to $1,800 more in interest charges over the life of the loan.
Buyers should compare financing offers and secure pre-approvals ahead of negotiations to get the best rate. Stretching out loan terms increases the total interest paid, so opt for the shortest term that fits your budget.
Credit Cards
As the prime rate rises, variable APRs on new credit card accounts follow. This means balances carry steeper interest charges each month. Paying off cards in full avoids finance fees. But for those who carry a revolving balance, it’s wise to lock in low introductory rates. Transferring to a 0% card can provide over a year of rate relief.
Issuers also often hike rates on future purchases. To lessen the blow, request a lower rate, pay down balances ahead of time, or shift spending to lower rate cards. Read disclosures to understand how rates may change over time.
Private Student Loans
Variable rate private student loans will see payments go up along with interest rate hikes. On a $30,000 loan at 4%, monthly payments would be around $333. At 6%, payments jump to $339, costing $720 more in interest per year.
Federal student loans carry fixed interest rates, so rising rates only impact new loans. Refinancing while rates are low could lead to long-term savings on private student debt. Federal loans may also be refinanced, but benefits like income-based repayment are sacrificed.
Personal Loans
Personal loan rates are also increasing with the prime rate, making borrowing more expensive. Someone paying off $15,000 over 3 years would owe $1,800 more in interest if rates rose from 5% to 7%, for instance.
While online lenders advertise low rates, offers are changing quickly with market conditions. Comparison shopping across multiple platforms helps discover the most competitive financing. A cosigner can also help secure better terms.
How Existing Loans Are Affected
In addition to making new credit costlier, rising interest rates also impact affordability of existing loans. Here are some ways climbing rates influence loans you already have:
Mortgages
Many homeowners have an adjustable-rate mortgage tied to benchmark rates. As the Fed hikes rates, ARM resets cause payments to increase significantly, often by hundreds of dollars per month. Home equity lines of credit (HELOCs) also adjust upward.
Refinancing an adjustable mortgage to a fixed rate ahead of resets provides payment stability. Shortening loan terms through refinancing can also offset higher rates with lower principal. Review loan disclosures to understand upcoming adjustments and options.
Auto Loans
Buyers who took out a new car loan when rates were lower are stuck paying higher rates on existing loans. Refinancing is an option, but only if you qualify for a lower rate based on credit, income and collateral. Defaulting on a loan is never wise, as lenders can seize the vehicle.
Paying extra toward principal is the most direct way to combat inflation. On a $25,000 loan, an extra $100 monthly cuts interest paid by $1,800 over a 5 year term. Trading in or selling the vehicle are other ways to get out from under a high rate auto loan.
Credit Cards
Credit card holders are very exposed to variable rate hikes. Paying only minimums becomes more costly as rates rise on revolving balances. A $5,000 balance at 15% APR costs $1250 per year in interest. At 20%, that jumps to $1667 annually – $417 more.
A balance transfer to a 0% introductory card remains one of the best ways to save on interest. Consolidating other high rate debts onto lower rate cards is another strategy. Avoid racking up more card debt, and try to pay off existing balances aggressively before rates rise further.
Student Loans
Existing federal student loans are fixed rate, so rising rates don’t affect payments. But they can impact decisions around consolidating or refinancing. Private student loans with variable rates will see payments increase. Refinancing when rates are low ensures stable payments, but federal loan benefits will be forfeited.
For private loans, call the lender to check if rates can be reduced. Paying ahead on principal also negates rate hikes. Look into income-driven plans if struggling with payments. While not ideal, deferment or forbearance are options to avoid defaulting if needed.
HELOCs
Home equity lines of credit have adjustable interest rates tied to the prime rate. As the Fed raises rates, HELOC rates follow. This increases the cost of accessing credit. Minimum payments also jump when rates adjust upward. With home values falling in some markets, HELOCs may be frozen or suspended by lenders.
To save on interest costs, only use the HELOC when necessary. Pay down balances quickly and look into fixed-rate consolidation loans if repayment becomes unaffordable. Learn when rate changes will occur and anticipate higher payments. Have a plan before tapping home equity.
Other Debts
Many other forms of consumer debt – personal loans, payday loans, pawn loans, etc. – have rates that will rise with the prime rate. This especially impacts borrowers already struggling with payments. As interest takes up more of monthly budgets, staying current becomes harder.
Refinancing high-rate debts at lower rates gives some breathing room. But the reality is paying debts off faster is the only sure way to avoid ballooning interest when rates rise. Developing a budget, increasing income, and limiting spending are key to making headway. Prioritize high-rate debts and minimums on others.
Strategies for Coping with Rising Rates
The Federal Reserve is intent on fighting inflation. That means consumers should prepare for interest rates to keep rising throughout 2022 and into 2023. Here are some top strategies for reducing the impact on personal finances:
- Lock in low rates now – For large loans like mortgages and student debt, move quickly to secure low fixed rates before they climb higher. Shopping aggressively for the lowest rate will pay off over time.
- Consolidate and refinance – Combine debts into new loans at lower rates to save substantially on interest, and refinance existing loans when possible. Focus on variable rate debts first.
- Shorten loan terms – Pay debts off faster by choosing shorter terms. This offsets higher rates by reducing the principal and total interest paid over the life of the loan.
- Pay off cards and other high-rate debt – Credit cards, payday loans, and other excessive-rate debt grow rapidly more expensive as rates rise. Make these a priority payoff target.
- Increase monthly payments – For non-revolving debt, add extra principal to monthly payments to negate rate hikes. Even small increases make a difference over time.
- Limit new borrowing – New debt takes on the higher prevailing interest rates. Avoid fresh loans and financing unless necessary for major purchases.
- Tap home equity judiciously – HELOCs and cash-out refinancing let homeowners access equity at low rates. But only utilize this credit carefully if home values decline.
- Review terms and disclosures – Understand how and when adjustable rate debts may change. This avoids surprises and gives time to prepare for payment changes.
- Build savings buffers – Emergency funds prevent relying on credit as rates rise. Save more aggressively to cover lost income and higher interest costs in a bind.
Rising rates present an obstacle to borrowing and repayment, especially for those on tight budgets or with significant debt levels. But by taking proactive steps to lock in low rates and pay down balances, consumers can mitigate the impact of climbing interest expenses. While the Fed hopes to tame inflation with higher rates, individuals will need to exhibit caution and financial discipline to manage increasing borrowing costs.
How Different Types of Borrowers Are Impacted
Rising interest rates affect everyone with loans and debt. However, the specific impacts often vary based on individual financial profiles and obligations. Here is a look at how some common borrower types may deal with the challenges of climbing rates:
Homebuyers
Higher mortgage rates make purchasing a first home more expensive. However delaying the purchase in the hope of lower rates in the future also runs the risk of home prices and rates going up further. Looking at current rates and staying within budget is often the best move for new homebuyers in the near term. Stretching finances too thin could be painful if rates continue rising.
Retirees
Retirees living on fixed incomes are very vulnerable when rates rise, especially if carrying credit card balances, ARMs, and other variable-rate debts into retirement. Refinancing mortgages and consolidating debts ahead of time is wise to lock in low fixed rates and affordable payments. Drawing down retirement savings to pay off debts also helps stabilize monthly budgets.
Low-Income Households
For lower-income households already struggling with debt payments, climbing rates stretch budgets even further. Seeking subsidized lending programs, housing assistance, and other social services can provide relief. Avoiding high-rate alternative financial services like payday loans is also key to controlling interest costs. Prioritizing essential needs first is necessary to get through the period of higher rates.
Small Business Owners
Entrepreneurs with business loans may choose to lock in low fixed rates to provide stability for planning. Variable rate lines of credit also become more expensive. Countering rising borrowing costs by increasing prices, improving efficiency, and controlling other expenses allows businesses to remain profitable when rates are high.
College Students & Recent Grads
Since federal student loans have fixed rates, current college students are not impacted apart from rates on any private loans. However graduates entering repayment will face challenges keeping up with payments if variable rate private loans exceed budget. Refinancing while rates are low provides an opportunity to lock in affordable payments.
High Earners & Wealthy Households
Higher income households with large amounts of low rate debt for homes, cars and education stand to take a hit as rates reset at higher levels. While able to absorb the increases more easily, it still erodes disposable income that could be invested or spent elsewhere. Even the wealthy benefit from refinancing and debt reduction strategies.
While everyone feels the pinch from climbing interest rates, proactive planning tailored to your specific financial situation and loan portfolio can help smooth the impact. Talk to financial advisors and lenders to understand all available options.
Outlook for Interest Rates and Beyond
The Fed has indicated they expect to raise their benchmark Federal Funds rate several more times in 2022 as they attempt to cool inflation. Most economists predict rates will rise by another 1-1.5% by the end of the year. This would take the Fed Funds rate to between 3.5-4% after starting 2022 near zero.
Rising rates appear set to continue into 2024 as well, though the pace depends on whether inflation cools substantially. Long term projections put the terminal rate for this cycle around 3.5-4%, up from 2.5% in the previous cycle. The Fed also began reducing bond holdings in mid-2022, which puts further upward pressure on rates.
When the pandemic first hit, the Fed took dramatic action by cutting rates to near zero in March 2020. This helped support the economy and restricted credit markets. Nearly two years later, with inflation hitting 40-year highs, the central bank is quickly undoing the stimulus enacted early in the health crisis.
The prognosis is that the era of historically low interest rates has firmly come to a close. Borrowers should brace for a period of rising rates, likely lasting two years or more. This new paradigm requires adjusting financial plans and debt paydown tactics to succeed in a higher rate environment.
Being judicious about new borrowing, focusing on variable rate vulnerabilities, and strengthening personal balance sheets are prudent strategies as rates march steadily upward. With careful preparation and adaption, consumers can navigate coming challenges while pursuing financial goals.
